If economics is the dismal science, then accounting must be its stepchild. For most, accounting is a highly necessary if utterly boring discipline that has created a stereotype for its practitioners as people with little internal fire or personality — the proverbial bean-counter.
But since last spring, the popularity of LIFO (Last In, First Out), an often-used and fairly complex accounting system, has resulted in a virtual stampede of outrage and protests from manufacturers and wholesalers when they learned it might be repealed.
Many of them consider LIFO to be a valuable tool in their accounting practices. It is a method for recording the value of inventory. Simply put, a company would record the last units purchased as the first units sold.
The benefit to LIFO is that it can delay the recognition of profits and defer tax payments, allowing businesses that use it to avoid paying taxes on the artificial, inflated value of their inventory. (To do so, businesses must request permission from the IRS to use this accounting method and must file IRS Form 970, Application to Use LIFO Inventory Method.)
The issue about the potential repeal began when then-Senate Majority Leader Bill Frist (R-Tenn.) brought up LIFO as part of an energy bill in April 2006. The LIFO issue coincided with Frist's much-ballyhooed “gift” of $100 to help some taxpayers offset the then-high cost of gasoline. He threw in LIFO as a measure to keep the bill revenue neutral, implying that it could be a source to pay for the rebate.
But according to Jade West, a founding member of the LIFO Coalition and senior vice president of government relations at the National Association of Wholesaler-Distributors, Frist probably had no idea of what LIFO really did or what it meant to the business community.
“It caught everyone by surprise; no one knew it was coming,” says West.
The outcry against the repeal was so rapid and vociferous that Frist withdrew it the following Monday. “The business committee was enraged that no thought was given to the implications of the repeal,” says West.
According to West, while some associated LIFO with big business, especially oil companies that used the practice for favorable tax advantages, small businesses use it extensively.
West says the Frist proposal provided a stunning example of how business-people can move quickly and forcefully when an issue directly affects them. The coalition was born literally over the weekend. Through an avalanche of e-mail exchanges between West and NAW President Dirk Van Dongen and their colleagues in the D.C. trade association community, they agreed to discuss the issue at a Monday meeting.
“We packed our conference room, and when you consider that it was Washington, D.C., and nothing had started until Saturday, two days earlier, it gives you a flavor of how intensive that response was,” she says.
“The intensiveness and fear of the prospects for repeal were stunning.”
Though Frist withdrew the proposal, the issue is not dead.
Frist did not run for re-election and is no longer in the U.S. Senate. The issue fell into the lap of Sen. Charles Grassley (R-Iowa), then-Chairman and now Ranking Member of the Finance Committee, who did not kill the idea of repeal.
The matter is currently in limbo. It is not moving along the legislative process nor is any legislation pending. However, the repeal of LIFO is still sitting on the lists of offsets (ways to raise funds or reduce costs) in the Finance Committee, according to West.
“Senator Grassley has gone on record that he would not support LIFO in the context that it was originally raised last year,” West said. In the fall of 2005, there was some movement to repeal LIFO only for some oil and gas companies, according to a report in The Wall Street Journal. This issue lay dormant until Frist raised the LIFO question again. West says Grassley indicated that if the finance committee reconsidered the repeal, they would examine it in the context of all industries.
Though there is no evidence on precisely how Grassley views the issue, it is possible that constituents from his native Iowa who are farm-equipment manufacturers and distributors might have made an impact. Grassley proudly notes on his official website that he is the only working family farmer in the U.S. Senate. After the LIFO issue fell under his jurisdiction, farm-equipment manufacturers and distributors from Iowa visited him, explaining that a repeal of LIFO would hurt their businesses.
“If I were to hazard a guess, it would be that we would prevail, but that is only a guess,” says West.
The appeal of repealing LIFO is that it is obscure to virtually everyone except accountants and seems like an ideal target for raising money with the potential loss of various revenue streams such as the Alternative Minimum Tax. Yet LIFO has been a common practice for financial and tax reporting since the 1930s.
No one knows how much money the repeal might bring to government coffers. According to The Wall Street Journal, Exxon's LIFO accounting method raised the company's costs in 2005 by $5.6 billion, substantially reducing its tax liability.
But while big oil or gas might draw press attention, the small businesses that use it would take the greatest hit if Congress repeals it, according to West. For now, the coalition's task is to continue a process of educating the leadership of the Finance Committee and the Ways and Means Committee about LIFO and members of Congress about the negative impact of its repeal.
West reiterates that every affected businessperson should contact their Congressional representatives and let them know they oppose the repeal. She also noted that if a company has employees in other congressional districts or states, the employer has a legitimate reason to contact the members of Congress in those areas.
Nothing can have more impact on a legislator than the expressed interest of a constituent or someone who has influence over constituents, says West.
West took a moment to praise HARDI Vice President Talbot Gee for his active and effective support in the repeal movement. “He's a perfect example of someone at a trade association who puts forth his interest and effort on a very important issue,” she says.
Tom Peric' is the editor of HVACR Distribution Business magazine. Contact him at 856/874-0049 or [email protected].
The NAW received numerous comments about the potential repeal of LIFO.
Here is a sampling of (mostly) unedited comments:
That's about the dumbest, most irrational move without any economic sense. Wow. All for a tank-and-a-half of gas???? Just please tell me [my senator] did not vote for this.
In our company, we do not use LIFO because of the constant changing nature of the products that we sell. However, there are very legitimate economic as well as tax reasons for electing LIFO, not least of which are inflation issues. In any case, I would expect that there are a number of wholesalers, particularly in the commodity trades, that have built up enormous LIFO reserves and for which it is very important. Wow. This is really stupid!
Most of our inventory is accounted for under the LIFO method. We currently have a $15M LIFO reserve on a $75M pre-LIFO reserve inventory valuation. If I read the attachment correctly, we would have to bring that $15M into income over the next 20 years. That would have significant taxable income impact on our company.
This would have a huge impact on our company (to the bad) — we currently have several million in LIFO reserves, a large portion which has accrued during the last few years of large price increases. I agree this is the most ridiculous thing I have seen our Congress do lately (and that takes some doing) — how can we fight this thing?
The repeal of LIFO accounting will have a significant detrimental effect on my wholesale distribution company.
We have been using LIFO since 1974. It is a useful and fair accounting method that immunizes us from paying corporate income tax on the “profit” that is created only on the inflation of inventory value. This is “profit” that we cannot spend or take to the bank.
Our current LIFO reserve is at $491,455. If LIFO is repealed, then we would have to declare that all as income and pay corporate taxes on it. Even with the provision that we would have 20 years to pay it back, it is still a significant hardship. Equally significant is that if LIFO is repealed, the $491,455 would then generate a deferred tax liability on my balance sheet. That would then reduce the value of my company. Everything from valuation for sale to loan covenant ratios could be negatively affected.
We need a full court press to fight for the retention of LIFO and not throw it away for a silly grandstanding $100 one-time payment.
[We] use the LIFO method of inventory accounting. Our current LIFO reserve is approximately $4.250 million. Using a rough tax percentage of 38%, the impact of repealing LIFO would add an additional tax burden of $1.615 million to [our] tax amount.
A repeal of LIFO would mean millions of dollars MORE in taxable income to any of us on the LIFO method of stating our inventories. This is a huge impact on our bottom lines and would mean we would have to pay thousands more in taxes.
Yes, our company is on the LIFO method of inventory valuation. It has helped us tremendously, especially in the past few years with the unprecedented pace of price inflation in commodity and chemical-related products in our industry that have been driven up by unprecented global demand from countries like India and China.
I run a $120 million family-owned supply business, and we would be affected significantly. As an example, last year we recorded $800,000 of an increase to our LIFO reserve. Without this, we would have paid an additional $320,000 in taxes.
We, as wholesale distributors, have already paid the price for rising energy costs in our own operating expenses. How can anyone ask us to pay even more with a “knee-jerk” proposal as the repeal of LIFO inventory methodology.
We stand united with our fellow distributors.